summitV I E W                                               summit creek    “Politics is the art of                       ...
summit creek             on page 4, in the quote titled The             Bottom Line. Rosenberg says “[t]he             wor...
that real return. This avoids the benchmark-hugging behavior that is typically induced bypolicy portfolios.”Francois Traha...
I Want to Break Free, or,             Quotes:                                                    Strategic Asset Allocatio...
Daring to Compare Todayto the 30’s                                                    In 2010, the authorities seem to hav...
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July 2010 summit_view.2-1

  1. 1. summitV I E W summit creek “Politics is the art of of a trade agreement between Taiwan looking for trouble, and China. For two entities embroiled in a dispute over sovereignty for the last 60 finding it everywhere, plus years, the signing of the agreement summitVIEW represents a form of detente. Bloomberg diagnosing it incorrectly reports, “in the trade agreement between the sovereignties China will also open and applying the wrong markets in 11 service sectors such as banking, securities, insurance, hospitals and accounting, while Taiwan agreed remedies.” to offer wider access in seven areas, including banking and movies, the two sides said. They also signed an agreement Groucho Marx on intellectual property rights protection.” 1 The agreement appears to reflect theH ow about General Stanley McChrystal? Flying thoughts of Mohamed El-Erian, Chief July 2010from the opposite side of the planet to be fired by Executive Officer of PIMCO. El-Erianthe president certainly cannot be easy on the ego. stated in an article titled Driving WithoutMcChrystal’s visit to the White House lasted around a Spare, that the new normal is a world ofthirty five minutes or so. A life in the armed forces “changing risks and opportunities.” Forcomes to a close in a brief firing from the Commander this global economic transition period,in Chief. Nothing like going out with a bang is there? investment with the safest carry will be “in sovereigns that, due to their economicWhat is most interesting in the story is not so much that and financial fundamentals, are trulya man was fired for insubordination. Of most interest core countries in the midst of the globalis a quote from Politico suggesting the writer of the paradigm shift.”Rolling Stone article, Michael Hastings, was able towrite the piece because, as a freelance journalist and As readers of prior SummitVIEWs know, anot a beat reporter, “burning bridges by publishing primary concern is the current level of risk inmany of McChrystal’s remarks” was not a worry to the system or, rather, the financial markets.him. Frank Rich, in the New York Times on June 27, Relying on your local newspaper or news2010 said, “Politico had the big picture right. It’s the program to provide the proper insightHastings-esque outsiders with no fear of burning likely will engender confusion and a beliefbridges who have often uncovered the epochal stories in false realities. If one were to follow themissed by those with high-level access.” national media attention on the imminent threat of inflation, the result would be aWow! How does one feel? Again, SummitVIEW is belief that the US is doomed to experiencereminded that what one often reads or hears in the inflation very soon. Reality is likely to benews just may not be the full picture. Why would quite different. Recent housing data pointsanyone want to report the ugly truth when spin to the continued decline in real estateis so easily digested by the American populace? prices. Although there does exist pricingWhat else is not being reported for fear of burning power in some industries, with a pillarbridges? Where is Clark Kent when you need of economy, real estate, still experiencinghim? SummitVIEW is beginning to understand the declining values, the likelihood of inflationmotivations for the creation of Superman in 1939. See rearing its ugly head in the next few yearsRosenberg’s quote on page 5 titled, Daring to Compare is low. Wage increases? Not happening.Today to the 30’s. Unemployment rate declining? Nope.Another news item of interest is the announcement The data point most telling to SummitVIEW see disclaimer on last page is that which is cited by David Rosenberg
  2. 2. summit creek on page 4, in the quote titled The Bottom Line. Rosenberg says “[t]he world is awash with $222.5 trillion of total liabilities across publicsummitVIEW and private sector claims, or the equivalent of 362% of global GDP. Extinguishing this debt will be deflationary even as central banks will be forced to print money as an antidote and we are really in the early stages of this deleveraging cycle.” Rosenberg goes on to say in Dinner with Dave from June 30,2 2010 the following: Resolving the pension crisis in theJuly 2010 U.S. though [sic] a longer work- life and higher contribution rates is surely going to mean that deflation, not inflation, as it pertains to many discretionary segments of the consumer spending pie, is going to be the primary trend for some period of time; likely five years or more. In other words, the time to be worried about inflation is really beyond our forecasting horizon. Think about the ratio cited above for a moment. On a global scale there exists over 4 times (and rapidly approaching 5 times) loss of capital. In an environment where most the level of debt as the level of annual global underfunded pension funds are holding out production. As we all know most of that for the return of an equity bull market, the debt is held in the developed world. Without underfunded state of pensions is likely to get extend and pretend accounting standards in the worse than better in the near term. banking and mortgage industries, where would equity values be today? As leading economic 2010 is likely to go down in history as a indicators roll over in the United States, few seminal year. The confluence of events shaping choices are available that have not already been geopolitics and global economics are starting to deployed. How do equity values hold up when make their mark. Although the events will be the economic engine is slowing and leverage the focus of headlines, the response to the events is excessive. As an investor one should seek is how our time will be defined. SummitVIEW high earnings yield companies (that is low price holds to the belief that, although the transition to earnings) with little to no leverage, if you to a new period of growth will be rife with have to be in stocks that is. Otherwise, holding strife and stress, a new period of prosperity will cash, high quality debt, and sovereigns of those emerge on a scale few can forecast. countries that are recipients of the new economic paradigm likely will prove prudent. Getting through a stormy sea of debt and traction- less economic growth requires proactive risk Protecting one’s wealth in this epochal transition assessment and management. As James Montier is of primary importance. Long term asset of GMO LLC says, as quoted below, “[h]aving performance averages are irrelevant when risk defined the [return] target, managers should be is defined as the probability of the permanent given as much discretion as possible to deliver
  3. 3. that real return. This avoids the benchmark-hugging behavior that is typically induced bypolicy portfolios.”Francois Trahan, Vice Chairman and ChiefInvestment Strategist at Wolfe Trahan & Co.,expects the forthcoming period of deflation to be summitVIEWreflected in the equity markets with lower priceto earnings multiples. In research titled Timeto Throw Out Your Textbooks, Trahan states, “thefact is that the majority of empirical data showthat lower interest rates are consistent withlower P/E multiples for the market.” EchoingSummitVIEW’s sentiment that our time will bedefined by the responses to current economiccircumstances, Trahan goes on to say, “[w]e 3hope policy makers will be somewhat proactiveand the market won’t have to once again forcethe “invisible hand”. July 2010In closing I turn to the words of Woody Brock: To sum up, what we are experiencing is not an event-driven turning point as in 1990, but rather a conceptual revolution in which much received wisdom about the role of the state and economic prospects for the future is being stood on its head. On both sides of the Atlantic, there is a sense that the Social Contract has been broken, and that government is the true culprit. What a change from a year ago when bankers were deemed the sole villains! The historian Simon Schama detects the beginnings of the Age of Rage, and he is probably right. The stakes are very high, and the political and economic consequences will be severe.1Recent market volatility is a reminder to allinvestors to fasten seat belts. The wild ride isjust leaving the station.1. Brock, H. Wood, Profile May 2010, Is the “Age of Rage” at Hand? - SovereignDebt, the European Crisis, and the Euro, Strategic Economic Decisions,
  4. 4. I Want to Break Free, or, Quotes: Strategic Asset Allocation ≠ Static Asset Allocation Driving Without a SparesummitVIEW Clients should liaise with their managers to Over the next few years, Australia and Canada set a “realistic” real return target (recognizing will constitute the analytical battle-ground as that available returns are a function of the elements of the new normal come head-to-head opportunity set, not a function of the needs of with those of the old normal. Our sense is that the fund). After all, the aim of investing must the two countries’ exposure to the dynamic surely be “maximum real returns after tax” as Sir components of global growth - through direct John Templeton observed long ago. None but a trade links with Asia and the commodity angel - few very lucky fund managers get to retire on will likely outweigh the drag from the legacy of relative performance. household leverage (Australia) and the economic4 links to the U.S. ( Canada). Having defined the target, managers should be given as much discretion as possible to deliver For investors, this translates into a secular period that real return. This avoids the benchmark-July 2010 of changing risks and opportunities: hugging behavior that is typically induced by policy portfolios. • The distribution of global outcomes is going through a transformation, both in Of course, it creates problems for measurement. terms of overall shape (flatter) and tails Indeed, as I mentioned at the beginning of (fatter); this paper, the most common response when I • It is a world where several of the old present these arguments is, “So, how should we simplifying adages that once brought measure you?” This obsession with performance comfort to investors - such as industrial measurement at the expense of investment sense country governments constitute interest is disturbing to me. There is no easy mark to rate risk while emerging economies judge fund managers against. This may actually involve credit risk - require considerable be a good thing. It may force investors to allocate refinement; capital on the basis of process: i.e., you will only let managers that you trust and understand run • It is a world that calls for a broader your money. [emphasis added] investment universe and guidelines and , for those who use them, revamped James Montier, GMO LLC May 2010, “I Want to Break benchmarks that better capture the world Free, or, Strategic Asset Allocation ≠ Static Asset Allocation” of today and tomorrow rather than that of yesterday; The Bottom Line • It is a world of significant country, regional and instrument differentiation when it The bottom line is that all levels of society, and comes to harvesting equity and credit across most countries in the industrialized premiums in high-quality corporates, world, have far too much debt and far too financials and emerging markets; much debt-servicing costs in relation to income. The world is awash with $222.5 trillion of • It is a world where the currencies of the total liabilities across public and private sector emerging (as opposed to submerging) claims, or the equivalent of 362% of global GDP. economies will continue to warrant a Extinguishing this debt will be deflationary even greater allocation over time; and as central banks will be forced to print money as • It is a world where the safest of carry an antidote and we are really in the early stages will come from duration and curve in of this deleveraging cycle. sovereigns that, due to their economic and financial fundamentals, are truly David A. Rosenberg, “Breakfast with Dave,” Gluskin core countries in the midst of the global Sheff & Co., June 22, 2010 paradigm shift. Mohamed El-Erian, PIMCO, “Driving Without a Spare,” Secular Outlook, , May 2010
  5. 5. Daring to Compare Todayto the 30’s In 2010, the authorities seem to have only two choices: allow defaults, which lead to deflationComing off a crash (‘29) and rebound (‘30); and tremendous stress to the political system andaftermath of an asset deflation and credit public order; or inflate so that debts lose their summitVIEWcollapse banks fail (Bank of New York back significance, which eventually leads to hyper-then, Lehman this time around); natural disaster inflation and tremendous stress to the political(dust bowl then, oil spill now); global policy system and public order. Growth is a theoreticaldiscord (with the U.K. then, with Germany way out of this dilemma, but with shrinkingnow); geopolitical threats; interventionist populations and increased regulation, Europegovernments; ultra low interest rates (long bond cannot manage this option. The US might, butyield finished the 1930s below 2%); chronic the way will be difficult. Cascading defaultsunemployment (25% then, 17% now); deflation will strip away many entitlements upsettingpressures; competitive devaluations; gold bull the rentiers [the debt owners, or, rather, the 5market (doubled in Sterling terms in the 30s); beneficiaries of the coupon payments] and thosedebt defaults; sputtering recoveries and rallies; who had planned to become rentiers in the future.onset of consumer frugality. Countries that choose to allow defaults will see July 2010 their currencies rally as there will be a shrinkage David A. Rosenberg, “Breakfast with Dave,” Gluskin of currency outstanding increasing the value of Sheff & Co., June 24, 2010 the rest, but collapsing equity markets will test their resolve at every turn. We rentiers will beHow The Middle Class, Or lucky if we can enjoy our dotage.The New Rentiers, Is Stuck John R. Taylor, Jr., Chief Investment Officer, “FXBetween Deflation And Concepts,” June 24, 2010Hyperinflation For a glimpse of changed societal mores, this headline speaks volumes.....The world is currently overwhelmed with debt,but underwhelmed with growth. Everyone istrying to export, but no country has embraced How Many Graduatesthe concept of expanding domestic consumption. Does It Take to Be No. 1?Although I personally like consumption, I aman American and therefore over-borrowed and Principals say that recognizing multipleunable to service the debt loads of my city, my valedictorians reduces pressure and competitionstate, and my country, not to mention my own among students, and is a more equitable waypersonal debt load. With the Americans no to honor achievement, particularly when No.longer available as consumer of the last resort, 1 and No. 5 may be separated by only theand no one else stepping up, global final sales smallest fraction of a grade from sophomorewill stagnate in the years ahead. As a result, science. But some scholars and parents haveglobal debt loads will become relatively larger. criticized the swelling valedictorian ranks as yetIf the world economic pie can not grow strongly, another symptom of rampant grade inflation,thereby lessening the relative size of global debts, with teachers reluctant to jeopardize the bestthe magic of compound interest will certainly and brightest’s chances of admission to top-tierbankrupt many governments and commercial colleges.entities. Currently there is a growing solvencycrisis impacting many Eurozone sovereigns and Winnie Hu, New York Times, June 26, 2010another one that is occurring within many statesand jurisdictions in the United States. It seemsquite obvious that many of these problems willlead to default and the loss of principal on a grandscale. In the next few years, a greatly increasedpercentage of all outstanding investment gradeglobal debt will default. Disclaimer: All material presented herein is believed to be reliable but we cannot attest to its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us for the purchase or sale of any securities.